Pension or Lump Sum? Compare Payouts and Options Before You Decide

About half of pension plan participants can choose to take their money in a lump sum when they retire. If you have that choice or are offered a buyout, what’s your best option?

Securing guaranteed lifetime payments directly from your company pension plan would seem to be a no-brainer, unless you’re facing a financial emergency and need the cash right away. However, taking a lump sum and deploying it wisely can give you more control … and sometimes more income.

When making your pension-vs.-lump-sum decision, here are some things you need to consider.

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The Case for a Rollover IRA

While the idea of receiving lifetime pension payments from your former employer sounds enticing, a rollover to an IRA can have real advantages. You get more flexibility and can control when you begin receiving retirement income payments and for how long. You can start taking penalty-free payments as early as age 59½ or you can delay them until the year you turn 72, when you must start required minimum distributions.

One important point to keep in mind: If you roll over the lump sum into a standard IRA, you’ll defer taxes on the distribution. Without a rollover, you’ll be hit with a big tax bill the year you receive a sizable sum.

Compare the Payout Amounts

The flexibility an IRA rollover provides doesn’t help much if you can’t generate at least the same amount of secure income on your own as your company pension could. On the other hand, even if your pension plan has the payout features you want, you should compare the income it offers to what you could get with a commercially available annuity.

Ask your employer for the amount of your lump sum and what your monthly pension payments would be. Then, get income quotes from an annuity provider representing multiple annuity companies. This will let you make an apples-to-apples comparison.

In some cases, taking a lump sum and rolling that over into an IRA and then purchasing an income annuity will provide greater income. If you can get a payout that’s slightly higher, it can add up to a lot of money if you collect payments for 20 or 30 years.

How Pension and Annuity Payments are Determined

There’s no magic in a company pension. Pension payments are based on the value of your account and an actuarial determination of your expected lifespan. Gender is typically not considered with pensions, because that’s prohibited by federal law.

Income annuities act like private pensions. In exchange for a single deposit, the insurance company will provide a guaranteed stream of income. An annuity is based on the same math as a pension, except the insurer does consider gender in determining payment amounts. That can disadvantage women because they are expected to live longer.

With annuities, you can choose how long the payments last. While most people choose a lifetime annuity, you can choose a set period, such as 15 years, and receive more annual income. This can be a good choice for people who have other income sources kicking in at a future date or who don’t expect to live to an advanced age.

An immediate income annuity offers payments that can start anywhere from immediately to one year after purchase. With a deferred income annuity, you can delay payments for more than one year. The longer you can afford to delay, the greater the annual income will be.

Do You Trust Your Company Pension Will Be Safe?

There’s also a comfort factor. How comfortable are you in letting your former employer control your retirement assets for the rest of your life?

Some people feel more secure receiving a lump-sum rollover to their IRA, rather than leaving their retirement money with their former employer's pension plan. And sometimes there’s good reason for unease: Some pension plans are underfunded. Most pensions are protected by the Pension Benefit Guaranty Corp., but only up to certain limits. With a multiemployer plan — a pension plan created through an agreement between employers and a union — the maximum annual guarantee through the PBGC is $12,870 for a worker with 30 years of service. That's far less than that person would receive from a solvent plan. For single-employer plans, which cover most people with pensions, for 2020 the maximum single-life benefit for a 65-year-old is $69,750 per year, according to the PBGC table of benefits.

Would You Trust an Annuity’s Insurer More?

A lump-sum payout transfers the risks associated with investment performance and longevity from the pension plan sponsor to the participant. But you can then transfer that risk to the annuity issuer. That’s the advantage of an annuity, as long as you choose a financially strong insurer. The insurers should list its rating from at least A.M. Best and perhaps other rating agencies on its website, which is a good starting point.

You don’t need to invest the entire lump sum in an income annuity. If your income needs are met using only a portion of your lump sum, you can split it between an income annuity and a portfolio of mutual funds or indexed and fixed-rate annuities in an IRA. That combination can provide growth potential while also guaranteeing income.

A rollover has another advantage. Pension payments end when the plan participant or a surviving spouse dies, but funds preserved in an IRA can be passed down to heirs.

The Bottom Line on an Important Decision

Taking a company pension is the course of least resistance, but it’s not always the best option. You may come out ahead if you take a lump sum and convert it into an income annuity yourself. Run the numbers to find out which is the better deal for you.